On November 16th, the House of Representatives unveiled a marked-up version of the long-awaited tax reform bill, the Tax Cuts and Jobs Act (TCJA) that was passed in the House. If you analyze it from a high level, this bill seeks to permanently reduce corporate rates, limit the number of personal income tax brackets, modify or eliminate a variety of itemized deductions and special interest tax credit incentives, repeal the estate and alternative minimum taxes and alter the taxation on foreign taxes.
A High-Level Overview of The Tax bill
Under the proposed plan, the corporate tax rate would be lowered from the current 35 percent down to 20 percent. Also, certain “business income” from pass-through entities would be taxed at 25 percent instead of at the owner’s individual rate. The bill would also repeal the corporate alternative minimum (AMT) and make existing AMT credit carryforwards refundable over a period of five years.
What Are The Most Important issues For The Restaurant Industry?
In the legislation’s current state, the repeal or rollback of several key credits and incentives could put restaurateurs under pressure, potentially outweighing the benefit of a reduction of their corporate tax rate. On the surface, a lower corporate rate sounds great, but some restaurateurs may rely on these tax credits that were signed into law as part of the PATH Act in late 2015: restaurant depreciation, WOTC, bonus depreciation, Sec. 179 business expensing, and the food donation tax credit (that are possibly up for being eliminated) while doing fiscal year tax planning.
There is a vast diversity of business entity models in the restaurant industry, including S corporations, partnerships, C corporations, etc. There are quite a few independent small business restaurant owners who pay individual tax rates, including sole proprietors and owners who pay taxes on income that comes through partnerships, S corps, LLCs, and other flow-through entities.
While the bill markup and the eventual transition to the Senate side could result in many changes to the legislative language, there are noteworthy provisions on the proverbial “chopping block” that restaurateurs need to keep in mind.
FICA Tip Credit
The “Credit for Employer Social Security and Medicare Taxes,” also known as the “FICA Tip Credit,” is a tax credit equal to the Social Security and Medicare taxes paid by an employer on certain employees’ tips earned working in a restaurant.
First, restaurant businesses should be aware of the proposal to modify the FICA tip credit. As restaurants with “tipped employees” know, this is one of the more highly favorable federal tax credit benefits currently available. The FICA credit was originally enacted as a way to reimburse restaurants for a portion of the social security tax required to be remitted on tips reported by tipped employees.
Under the current law, the FICA credit is computed with reference to the 2007 federal minimum wage rate of $5.15 per hour, which was frozen into the tax law for the tax years after 2006. Tips eligible for the FICA credit are those in excess of what’s needed to bridge the gap between the amount employers pay their tipped employees in cash and what they would pay them in cash if the minimum wage were $5.15 per hour.
The use of a frozen $5.15 for purposes of the FICA credit computation ensured that the FICA credit was not reduced every time the actual minimum wage has gone up since 2007.
Should the drafted legislation pass in the Senate, the FICA credit will no longer be computed with reference to the 2007 wage rate of $5.15 per hour. Instead, the credit will be computed by reference to the most current federal minimum wage in effect each month during the tax year. The net result is, that restaurants can expect a lower FICA credit since more tips will be needed to bridge the gap between cash wages paid to tipped staff and the current minimum wage.
So if this bill becomes law, all restaurants that claim the FICA credit will be required to comply with annual tip reporting requirements (i.e., completion of Form 8027).
Takeaway: This is going to result in a major reduction in the tax credit for full-service restaurants.
Another important aspect of the bill that restaurant owners need to be aware of is the proposal to repeal the Work Opportunity Tax Credit (WOTC). The current law allows restaurants to claim a Federal income tax credit (by up to $9,600 per each newly hired employee ) for a portion of salary and wages paid or incurred to eligible employees who begin work for the company before January 1. 2020.
This was originally created to incentivize companies to hire veterans, felons, food-stamp users, summer youth employees, disabled people and those on supplemental security income as well as a few others. But the following passage of this into law, this credit will be abolished.
Takeaway: This would possibly result in many restaurant companies owing more tax, especially Quick service restaurants that hire many employees that qualify for Work Opportunity Tax Credit.
Section 179 Expensing
Currently under Section 179, restaurant’s can expense up to $500,000 of the cost of qualifying property placed in service during a given tax year. This amount starts to be reduced if the total amount of assets placed in service exceeds $2,010,000, and is eliminated if the cost of eligible property placed in service exceeds $2,510,000.
The draft legislation of TCJA proposes that these dollar limits be increased to $5,000,000 and $20,000,000 for taxable years beginning after December 31, 2017. And before January 1, 2023, with plans to index for inflation. If enacted, this means that restaurants could expense up to $5,000,000 of asset additions in a given year, a favorable aspect of reform. Take note that there are taxable income limitations and other nuances that apply, and as a result, not all restaurants will be eligible to expense the full $5,000,000 in any given year.
Other, more wide-reaching aspects of the bill that you should be aware of, include the proposed repeal of the Domestic Production Activities Deduction (DPAD), a limit on 1031 exchanges to real property only and potential changes to pass-through entities.
Takeaway: One positive provision for restaurants in the tax reform legislation is the potential for a restaurant to write off up to $5 million of investment in qualified property under Section 179 (previously a maximum of $500K).
50% Bonus Depreciation
In 2017, 50% bonus depreciation allows restaurant business owners to deduct half the cost of a fixed asset in the year the asset is placed into service. Bonus depreciation is not contingent upon whether a taxpayer has taxable income and there is no limitation on the amount of bonus depreciation that can be claimed. Qualifying fixed assets must be brand new or original-use property and can include
- Point of sales systems
- Furniture, fixtures,
- And certain types of improved property.
Bonus depreciation deductions are tentatively set to dip from 50% to 40% beginning in 2018.
Then things like favorable write-offs available for remodels (up to 75% for companies with audited statements), leasehold improvements (potential 100% Sec 179 deduction possible) and taking advantage of increased deductibility available under the previously revised repair & maintenance regulation. It’s always recommended to consult a restaurant tax advisor about fixed asset or restaurant depreciation strategies.
Conclusion and Next Steps
The passing of the House bill represents the first actual detailed and major step toward tax reform under the Trump Administration. As it is currently drafted, most of the provisions would be effective for the 2018 tax year.
As we look ahead to the end of 2017, restaurants should take advantage of current tax benefits while they are still available and can help offset 2017’s high tax rates. These benefits include bonus depreciation, section 179 expensing, the WOTC credit and the FICA credit. It’s also important to keep in mind that until it actually gets passed in the Senate, and signed by President Trump, it is still just a bill, with nothing being completely set in stone. For now, we are advising our restaurant clients, to proceed with business as usual, executing short-term business priorities under the assumption nothing concrete will get passed until the end of the year.